For more than 15 years, private wealth's stock market indicator has been giving equity investors valuable pointers on how to allocate the equity portion of their portfolio. The basic idea is to find out when the relationship between opportunities and risks in equity investments is positive. And when it is not. Anyone who used this as a guide would have been able to participate in the long upward phases on the markets and avoid the major loss phases, at least in part.

How does the stock market indicator position itself with a view to the new year?

The stock market indicator combines three factors - economic indicator, fair value calculation and the results of the capital market seismograph.

The long-term corridor for the equity exposure in the portfolio is defined by an economic indicator and the editors' internal fair value calculations for the DAX. The idea is that a high equity exposure is advisable when the stock market is favorably valued and/or when the economy and thus company profits are improving. Caution is advised if the economy and earnings are expected to deteriorate and/or the market is very highly valued.

Within the corridor defined in this way, the results of the capital market seismograph determine the exact positioning. Oliver Schlick, Managing Director of Secaro GmbH, has been translating its results into a stock allocation scheme since 2017. If the seismograph signals an equity overweight, the private-wealth stock market indicator positions itself in the upper range of the long-term targeted corridor and vice versa.

Let us now look at the individual factors at the turn of the year:

The editors answer the question of whether the stock market is cheap or expensive using a long-term trend model that incorporates a broad cross-section of macroeconomic data. This calculation of the fair value of the DAX is based on data material since 1954. A year ago, it was adjusted to the expectation that central banks would tolerate more growth and higher inflation rates without raising interest rates. This assumption has since been confirmed on a sustained basis. Despite high nominal growth (real growth plus inflation), the ECB stuck to its minus interest rate policy.

Assuming that this new regime continues - from our point of view, this continues to be very plausible - the German DAX share index is currently more than ten percent below its fair value. Even then, however, the MDAX is still significantly overvalued.

Overall, the valuation of the German stock market is close to fair value. In concrete terms, this means that the valuation indicator is currently neutral.

What does the economic component say?

The answer is provided by the business climate of the Munich-based ifo Institute. Every month, researchers ask around 9,000 companies about their business situation and their expectations for the next six months.

In the past, business expectations in export-oriented German industry in particular have proved to be very accurate economic indicators.

If expectations fell three times in succession following a previous increase, the probability of an economic downturn in Germany increased. And in the global economy, too, darker clouds would then usually gather.

If expectations then improved again three times in succession, this was usually a signal of a positive turning point in the economy and corporate results - and thus at the same time a buy signal on the stock market.

Business expectations in the industrial sector had delivered a sell signal in July 2021 and had continued to fall in the months thereafter. For this reason, the private-wealth stock market indicator had reduced the equity quota in the summer.

Now there are signs - almost hidden - of a positive trend reversal. It is true that the ifo business climate as a whole has continued to decline in recent months. However, the ifo Institute reported an initial slight increase in business expectations in industry, which are crucial for the indicator, as early as the end of November. In December, expectations improved further. If this trend is confirmed in January with a third increase, the conditions for a positive turnaround would be met. The economic component of the stock market indicator would then once again give the green light for stocks.

How is the capital market seismograph positioned:

The seismograph combines various economic variables and distills from them the probabilities for three market states in the next month, modeled on traffic lights. Green represents the expectation of a calm, positive market. Yellow denotes the probability of a turbulent-positive market. And red indicates the probability of a or turbulent-negative market. If it rises significantly, a stock market storm is looming and it is time to get out.

The seismograph already painted a very positive picture for the entire year 2021. Oliver Schlick regularly derived the recommendation "significant overweight" in equities from this. Currently, the probability of positive, calm markets (green) is well over two-thirds. The probability for negatively turbulent markets (red) is, as Schlick reports, less than three percent below the sensibility threshold. The remainder is accounted for by the probability of positively turbulent markets (yellow). Schlick's conclusion: "The picture remains unchanged. The seismograph continues to recommend a significant overweight at the turn of the year."

Conclusion:

For the first seven months through the end of July, the private-wealth stock market indicator was 110 percent invested in the equity market. Economic signals were positive, valuations were not stretched, and the seismograph advised an overweight position in equities.

Then, in the summer, the private-wealth stock market barometer had reduced the equity allocation to the corridor between 45 and 75 percent in view of the economic difficulties. However, the positive data from the seismograph ensured that the specific equity allocation was not dramatically reduced, but was fixed at 75 percent.

The performance of investors who followed the stock market indicator was thus just as high over the entire year 2021 as if they had been invested at 100 percent for the entire year. However, they spared their nerves during the significant price fluctuations in the last five months of this year.

If the economic component actually delivers a buy signal at the end of January 2022, the corridor would be raised significantly again - to 75 to 115 percent. If the seismograph's allocation recommendation is then still offensive, a significant increase in the equity weighting in the stock market indicator would be the result.

Interesting: In the past, a two-step increase in ifo business expectations in industry was very often also followed by the third step, which cemented the trend reversal. We explicitly point this out to you because January is often a strong stock market month and the indicator's buy signal could come a bit late in this case. For some investors, it may therefore be opportune to increase the share quota somewhat now - at the risk of having to reverse this step at the end of January if business expectations deteriorate again.

I wish you every success with your investments in the New Year. But above all, stay healthy,

Yours,

Klaus Meitinger

Note: Despite careful selection of sources, no liability can be accepted for the accuracy of the content. The information provided in private wealth is for information purposes only and does not constitute an invitation to buy or sell securities.